Allot Ltd (ALLT) 2015 Q2 法說會逐字稿

Please go ahead.

Thank you very much and thank you all for joining us on our second-quarter 2015 conference call. My name is Rami Rozen and joining me today are Allot's President and CEO, Andrei Elefant, as well as our Chief Financial Officer, Shmuel Arvatz.

The press release announcing our Second quarter results is available on the Investor Relations section of our website at www.allot.com.

All results and expectations we review on the call are on a non-GAAP basis unless otherwise described as GAAP. Non-GAAP net income and non-GAAP net income per share excludes stock-based compensation expense, revenue adjustments due to acquisitions, expenses related to M&A activity, amortization of certain intangibles and inventory write-offs.

Please note that all earnings per share amounts are on a fully-diluted basis. A reconciliation of each non-GAAP measure to its nearest GAAP equivalent is available in the press release containing our second-quarter result.

Before we begin, let me remind you that certain statements made on the call today may be considered forward-looking statements, which reflects management's best judgment based on currently available information.

I refer specifically to the discussion of our expectations and beliefs regarding our pipeline and funnel of potential future business. Our actual results may differ materially from those projected in these forward-looking statements.

Certain material factors or assumptions were also applied in drawing the conclusion or making the forecast or projection as reflected in such forward-looking information.

I direct your attention to the risk factors contained in the annual report on Form 20-F filed by Allot with the US Securities and Exchange Commission and those referenced in today's press release, both of which detail factors which could cause our actual result to be materially different from those projected in the forward-looking statements.

With that, I would now like to turn the call over to Andrei.

Thank you, Rami, and thank you all for joining us today. In today's call, I will highlight Allot's result and share with you some of Q2 achievements. Then I will hand over our call to our CFO Shmuel Arvatz for a short review of our financial performance for the quarter.

During the quarter, we continued to execute upon our growth strategy. We have won a number of new large and strategic customers. We made significantly inroad into the security market, and in our legacy business we are working closely with our customers to provide solutions in line with their CapEx challenges.

Second quarter results came in at $21.6 million, in line with our pre-announcement. We recorded a net loss for the second quarter of $3 million or $0.09 per share. This decrease is due to the low bookings in Q1, which reflects a longer sales cycle we are seeing in our legacy sector.

While we are disappointed with our revenues, we are adjusting ourselves to the new market reality for longer sales cycle. According to our strategic plan, we expanded our customer base with new strategic account, which will provide constant flow of revenue.

(Technical difficulty), bookings from new customers was well above our average. During the quarter, we won five new tier 1 operators, of which three are mobile operators. One of these mobile operators selected Allot service gateway Tera and our ClearSee solution for its new LTE network. This network targets tens of millions of subscribers.

The customer has already placed a multi-million dollar follow-on order at the beginning of Q3. We see this order as a validation to our strategy of increasing our installed base, creating greater stability in revenue.

Another new customer, this one a fixed-line operator, purchased our 100GE solution, which was delivered during the quarter. Moving into 100GE network is a trend we see with many fixed-line operators worldwide and we expect to see additional benefits from this trend going forward.

Large deals reached 21 in total, nine of which represents new customers; 15 came from mobile operators, five from fixed-line service providers and one from cloud operator. The mobile sector continues to be our main focus and we are pleased with the flow of large orders from this vertical.

During Q2, we received an expansion order from a tier 1 operator in North America. This security deal is in early rollout stage and we expect additional orders generating greater revenues from this customer during 2016. We intend to expand our footprint in North America, leveraging our security product offering, which, as opposed to our legacy offering, is not subject to any regulatory constraint.

We continue to maintain our control of OpEx. As part of our overall strategy, we increased our focus and shifted our resources to the faster growth areas such as security and monetization, thereby improving efficiency. These actions help to maintain a flat OpEx while integrating the Optenet's team. Going forward, we will continue to carefully monitor our OpEx and operating efficiencies.

During Q2, we continued to grow our value-added services. VAS represented 43% of overall bookings, up from 38% in Q1 and 31% for the entire 2014. To remind you, our VAS category is divided into four groups; security, monetization, analytics and optimization.

In Q2, we saw security and monetization accounting for 68% of VAS bookings. This reflects the trend we have seen in the market and validates our plan to capitalize on the growing demand for these services. We are continuing to see VAS as our main business driver in the coming year, and more specifically, security-monetization category.

Service providers use our security offering to increase their ARPU and improve customer loyalty, significantly increasing the value of their brand. They offer their subscribers value-added security services such as anti-malware, anti-spam and parental control.

Let me give you an example; one of our security customers, a tier 1 mobile operator with more than 20 million subscribers, began purchasing Allot's security services two years ago. Today they provide security services to over 5 million end users. They charge each end user an average of $1 per month, with a total of incremental annual revenues of about $50 million. Our security offering is effective to our customers because the benefit goes directly to their top line.

Another area where we made progress is on the NFV front, which we just recently announced. We have been working closely with HP OpenNFV, demonstrating security services in an NFV environment. We intend to continue developing innovative NFV related solutions and expect to start seeing meaningful revenues in late 2016.

We will continue to focus on the mobile vertical and we believe this is the fastest growing vertical in our market. Our leadership position in the fast growing vertical was recently validated in May 2015 by Infomatics when they recognized Allot as the mobile market share leader.

Finally, validating their confidence in our future growth, our Board of Directors have approved the issuance of a share buyback plan of up to $15 million. This plan is subject to the authorization of the Israeli court, which is expected during the fourth quarter of 2015.

Before summing up, I will turn the call over to Shmuel for a review of our financial results.

Thank you, Andrei. Before I begin reviewing with the financial result for this quarter, I would like to inform everyone that on this call unless otherwise noted I will refer entirely to the non-GAAP financial measures when discussing operational results.

Non-GAAP financial measures differ in certain respect from the generally accepted accounting principles and exclude share-based compensation expenses, revenue adjustment due to acquisition, expenses related to M&A activity, restructuring costs and amortization of certain intangible assets.

Turning to our second quarter results, revenue for the quarter were $21.6 million, down 23% year over year and down 27% sequentially. This is in line with the pre-announcement of last month. As a percentage of revenues, revenues in the Americas accounted for 21%; EMEA 59%; and Asia-Pacific 20%.

Product revenues for the quarter accounted for 56% of revenue, while service revenues were 44% compared to 66% and 34% split during the second quarter of 2014. Book-to-bill ratio in the quarter was above 1. During the quarter, we booked six seven-digit deals.

Moving on, gross margin for the quarter was 74% of revenue compared to 73% in the second quarter of 2014, up 1%. Gross margin may fluctuate on a quarterly basis. However, this result is in line with our typical range of 74% to 75%.

Operating expenses for the quarter were $18.9 million, up $100,000 compared to the same quarter last year and down about $500,000 sequentially. The sequential reduction in operating expenses was mostly due to the lower sales and marketing expenses as a result of lower revenues and the related variable costs such as commissions.

In addition, during the quarter we undertook some efficiency measures in order to align operating expenses with the revenue level. It is notable that in the second quarter we fully consolidated Optenet's result for the first time and therefore increasing our operating expenses base.

Our headcount including Optenet was 529 employees at the end of the second quarter, same as of the end of the first quarter of 2015 and up 67 employees from the end of 2014. The increase compared to last year was mostly due to the Optenet acquisition.

Operating results for the quarter were negatively impacted by the currency changes, mostly due to the depreciation of the euro and the Israeli shekel against the US dollar. On constant currencies as prevailed in the second quarter of last year, revenue were negatively impacted by about $2.2 million and expenses -- both COGS and operating expenses -- were positively impacted by about $900,000. So the year-over-year net effect on our operating results was about $1.3 million negative.

Net loss for the quarter was $3 million or $0.09 per diluted share compared to net profit of $1.9 million or $0.06 per diluted share in the same quarter last year.

Turning to the balance sheet, our cash reserves comprise of cash, cash equivalent and investment total $120.6 million, down $3.2 million compared to the previous quarter. During the quarter, we recorded negative operating cash flow of $2.3 million. DSO was 104 days, up from 72 days in the previous quarter. The increase was mostly due to the reduction in the quarterly revenue and we expect to return to our normal range of 75 to 90 days in the next quarters.

To conclude, while the second quarter results came in below our plan and expectation, we are encouraged by the progress we made in the security segment as well as winning new account and expect this win to contribute to our top line in the second half of 2015 and in 2016.

With that, I will turn the call to Andrei.

Thank you, Shmuel. To summarize, during Q2 bookings have picked up. We significantly increased our customer base according to our plan. We see the combination of our security solutions with our quality control and charging offerings is highly synergetic in driving future growth. And our security offering is gaining momentum, and as I said, we expect it to become a more meaningful part of our business in 2016.

With that, I will open the call for a Q&A session. Operator?

(Operator Instructions) Jason North, Jefferies & Company.

This is Jason North for James. First question here for OpEx. When you referred it being flat, was that referring to the fact that it was pretty close to flat sequential in Q2 or is that the expectation going forward for Q3?

When we mean flat, we look at the last quarter in Q2 2014. So we were flat compared to that quarter while we took in Optenet during the second quarter this year. So this is what we mean flat by when we say it's flat earlier.

Okay. Do you have anything commentary on go forward OpEx, what we could expect?

Yes, I would say that the OpEx is dependent on top line level, revenue mix, which carry also variable expenses in the selling and marketing and of course which can fluctuate from quarter to quarter. I would say, as I said in the previous call, that we expect about -- on revenues of about $26 million and within the typical growth margin we expect a breakeven point from -- operational breakeven point.

Jason, I would like to add to that that what we are doing is constantly optimizing our investment in the areas where we see the growth coming from. Specifically, we took some measures to invest more in the security and monetization space versus the more traditional or legacy areas like optimization where we had investments in the past.

And we will continue to monitor very closely our expenses in a way that we will optimize the investments that we are doing today in areas that we see that growth is coming from. So while doing that over the last year, we succeeded to increase the investments on the security side while keeping the OpEx level in general flat.

Great. Thank you. And the gross margins were -- I think it was within the range of the targets in Q2 but down sequentially. Just any kind of commentary on what to expect on that going forward?

Yes, in previous quarter, the revenue mix was favorable and therefore we gained one additional percent. However, we continue to say that the typical range is 74%, 75%. It may be higher than that in a specific quarter due to some more profitable deals or higher content of software in the revenue mix, but we still say 74%, 75% in terms of expectations and our internal planning.

Okay. Then for the buyback, that's a shift in strategy? If you could just reflect on what that means for your acquisition strategy.

I think that we have $120 million in cash and the $15 million is relatively a small portion. We think it's a good use of the Company reserve right now compared to the alternatives and also with regard to the current market price. It will allow us, first of all, to use the cash properly and we continue to look for M&A opportunities. So we have both option available to us right now.

Okay. And one final quick one, housekeeping. What was the percent of value-added service bookings in the quarter?

Value-added services accounted for 43% of total bookings.

All right. Thank you very much.

Thank you.

Thank you, Jason.

Joseph Wolf, Barclays.

Along that line in terms of the bookings, could you give us an indication of the length that your bookings stay in backlog these days? Has it extended from three quarters to four quarters? Is it faster than that, so you are doing book business in the quarter so it doesn't even go into the backlog? Just given the mix in the business, can we get a better sense of how we could track that a little bit?

Okay. In general I would say there's a big difference between new customers and the existing customers. New customers typically when they place a large -- I'm talking about the large orders or large projects -- when they place the first order, it relates to a full-scale deployment that we need to do in their network and this process can take between two to three quarters.

With existing customers, it's typically either expansions of existing deployment or just buying add-ons on the value-added services. And on those projects, it's either happening within the quarter or in a shortened time frame just because the projects are typically simpler and faster.

So there is a big variance between existing customers and new customers. In this quarter specifically, we had a significant portion of our bookings coming from new customers --

Hello?

(Technical difficulty) However, in terms of turning that into revenues, it takes us longer than with the existing customers.

Okay. I think I may have cut out, but I think got most of that answer. With the AT&T, DIRECTV may usher in a new kind of delivery and bundling in the US or may increase the take rate of bundles in the US, or at least according to our telco analyst. How is Allot seeing that as an opportunity? Is there a new opportunity now given new packages being offered to content anywhere? Is that an opportunity that has nothing to do with the old opportunities that you saw or perhaps had regulatory issues with?

I think that specifically for North America the main strategy that we have is to focus on our security services. We already had a very nice start with that, winning a tier 1 operator. We are making progress with another one. So we would focus more on delivering security services where the regulatory aspect does not exist.

And specific opportunities that we might have like in analytics or in other areas we'll of course explore, but as a strategy we would focus on the security services.

Okay. And I guess that was my last question. You gave us some metrics about the tier 1 mobile carrier with 20 million subs. You have been selling to them for two years and they have given offer to 5 million.

Is that some sort of take rate we can use as a figure of merit? How are they selling that? So they pay you upfront and then they sellout licenses or is there revenue -- is your revenue contingent on the take rate of their customers?

With this specific customer, they bought upfront their licenses. They bought it in steps. However, we are moving now to a different model where we will charge annual licenses for this service rather than fixed licenses for this service. What we gained from this increase in the take rate on top of the licenses is expansions, professional services that accompanied this project as part of the growth in the take rate.

If the take rate -- really going back to your question about the take rate, it really depends on the customer's strategy on how he wants to rollout the service. In some cases, they use an opt-in method. In some cases, they use an opt-out method. Sometimes they bundle it with other services.

So we are working also on that front with our customers on how to market it in the best way. Because what we experienced with those customers that we already have one or two years of experience is that it can create significant incremental revenues for them. And this is why they find this service very interesting for them.

You are considering parental control and DDoS, both types of security when you say security?

Yes, I put these two services as part of the security group. However, the service that we see the most is the anti-malware or web security services in general. The operator would call it Clean Pipes. And sometimes the parental control is just another feature or just another capability as part of that package that they are getting.

Understood. Okay, thank you very much, Andrei.

Thank you, Joseph.

Matt Robison, Wunderlich Securities.

I noticed in your commentary -- in your prepared comments you referred to legacy. It might be the first time you've actually used that term for the business. And I was wondering if you could first comment a little bit on the bookings on a year-over-year comparison if you look back to the second quarter of 2014 and look at the mix of what I tend to call platform technology, which is the gateway business versus the value-added services and how that's changed.

And when you talk about legacy, if that's what we talk about, because that's how we refer to gateways now. And also comment on how your pipeline looks in terms of gateway business versus value-added services?

And lastly for Shmuel, if you could give us a little bit of color on what your cash consumption budget is for this year obviously before the buyback?

Okay, so let's start with what we call legacy. When I mean legacy, I refer mainly to the optimization part of our business. So you can include the platform for those types of projects. However, sometimes we do sell our platform for the security services as well. So I refer mainly to the fact that if in the past part of our business was about bandwidth management, traffic management and optimization, that part I will consider as legacy.

We still see these projects, some of the new customers even came from this category. However, as a trend, we see that there is a shift to more services around security and monetization.

If I compare this quarter to Q2 in 2014, I would say that it's very noticeable to see that the percentage of our VAS significantly increased. So we see 43% of our VAS coming in this quarter versus 26% that we had last year. And we -- as we expected, we continue to see a trend that the value-added services are drawing. This is very encouraging for us. It's part of our plan.

Were the bookings this -- in the second quarter of 2015 as large as they were in the second quarter of 2014?

They were not in the same size, but this trend of value-added services wouldn't have significantly changed even if they were on the same number.

So you've -- is that a way of saying that even though the denominator was bigger in terms of the percentage per VAS, that you booked more dollar value in VAS this year than last year?

Yes.

Yes, yes, definitely.

Okay.

Matt, regarding the uses of cash, we think the guidance that we provided for the year, revenue guidance, I expect breakeven or positive cash flow in the next -- in the second half of the year. And therefore, the buyback program is very solid and serves we believe -- as we believe serves the shareholder's value and it's a good use of cash right now.

Yes. Is that really kind of a criteria for the court that you've got to have positive cash flow in order to have a buyback?

No. Right now the Board approved $50 million based on the cash we have right now, cash and investments, and the forecast and the fact that we don't have an outstanding financial debt and based on the outlook for the coming quarter. Thereafter, we will analyze the situation and will take it from there.

Thank you for taking the questions.

Thanks, Matt.

Alex Henderson, Needham & Company.

Just on the buyback since you were just talking about it, is there any impact on the tax rate given the Israeli tax laws when you execute a buyback? I'm pretty sure that there isn't, but I just want to check.

For Allot, there isn't. It may impact companies that utilize some of the approved enterprise tax regime. We are not in this position. So for us it will be a capital reduction, not using retained profit, and therefore, we need also court approval due to this fact. I don't anticipate tax -- the tier rate tax position in this case.

Second question and a pretty quick one, I didn't catch whether there was any 10% customers in the quarter.

We didn't -- we had six seven-digit deals. And in terms of 10% customers, we had one 10% customer in terms of revenue.

Right. And is it reasonable to say that securities on a quarterly basis or for the full year is still less than 5% of revenues at this juncture and while it's expected to ramp, it's still fairly small in the ballpark, the right size of the bread basket there?

I think it's much more than that. It's above 10% -- it's above 5%, sorry. However, you need to remember that as part of the -- when we talk about the value-added services, we refer mainly to the licenses of the security. We have many projects where on top of the security licenses we sold our subscriber management licenses because they were needed in order to deliver the service. We sold our service gateway platform because that was needed as part of the solution rollout.

So if you accumulate all the different elements, it's significantly more than 5%. A big part of our business is driven by this security services.

Again going back to what I stated also at the last -- at the call of the summer of 2014, we had in during 2014 close to 40% of value-added services coming from security services. And as I mentioned also back then, when we look at the value-added services, we in fact look at the drivers of our business. And all those elements later on roll down into the other categories like the platforms that we are selling, professional services that we are selling and additional services that we are selling.

All that is driven by the value-added services. And when we mean that we see that a big part of our business is coming from security and monetization services, it means that these are the main use cases that the customers want to deploy when they buy our solutions and our services. I hope it clears the picture.

Yes, that helps. Thank you. The second question, the gross margin question asked earlier, you mentioned mix. It looks like the mix was pretty heavily skewed to service relative to normal. Is the service margin helping or dragging down that gross margin percentage?

The service margins basically -- they are in this quarter specifically -- first of all, regarding the mix, the revenue mix was more towards -- in favor of the services due to the fact that the shortfall in revenues in the quarter was mostly in products. Generally speaking the low revenue put pressure on the gross margins due to some fixed expenses that we have. So overall the 74% is relatively -- shows relatively good mix of business in the quarter that was offset by low revenue and higher portion of fixed expenses.

I heard all of that in the first answer. My question is, is the service margin above or below corporate average?

It's above the average.

Thank you. That's helpful. On a technology question, we are seeing a very sharp increase in the percentage of WAN traffic that is shifting to secure socket layer and I was wondering if you could talk about the implications of that. If we go from 25%-30% of WAN traffic secure socket layer today to two-thirds, say, two or three years from now, does that negatively impact the optimization business? Does it negatively impact your ability to do some of the anti-malware, anti-spam and parental control if you can't see what's inside the traffic because it's a secured socket layer? How do we think about the implications of that?

Good question. So actually we are seeing in some countries a very fast pick up of the encrypted web traffic, mainly I would say in the developed countries. And actually in these countries, we see more demand for security services and monetization services, which are not impacted by this trend. We are rolling out these types of services in the developed countries and we can deliver and sometimes it goes along with the trend of using more and more encrypted traffic.

In some of the use cases that are related mainly to optimization, encrypted can decrease the value of the solution. And as I mentioned, we are seeing in general a trend that we are seeing less demand for that aspect not only because of encryption, it's also for other reasons. However, you are right that there are some use cases on the optimization side that cannot be delivered in the encrypted environment.

Again, however, from our point of view where we see the growth in the future is from use cases that are not impacted by this trend and even go along together very well with this trend.

I guess I'm not sure I understand the mechanics of that. Maybe we can do that offline. But how do you provide anti-spam, for instance, or anti-malware if you can't see inside the packet or inside the traffic flow to know what it is? I don't understand how that works. Could you give us a brief explanation of how you are able to do that? I assume you are not getting the key from the subscriber to unlock the SSL.

For some services, we can get the approval from the end user to open it in order to provide the security services. However, we can identify the open traffic without any problem. And on top of that for the encrypted traffic, we can know from -- we know from which domain it came from and we have other methods to identify whether this is coming from a valid location or not. It depends on the definition and how you want to customize the product.

But again this service is being rolled out in many countries and we have ways to work together with this encryption trend.

Okay, that's helpful. Thank you.

(Operator Instructions) Catharine Trebnick, Dougherty & Company.

I wanted to know about the NFV. In your opening remarks, you talked about your relationship with HP. Do you have any other relationships brewing? And then where do you think all the carriers are in this implementation? And then do you think the way the carriers are looking at this, has it probably impacted your revenue from your product side at all? Thanks.

Thank you, Catharine. So NFV is -- first of all, I would say NFV is a very good trend for us and we expect -- and we would like operators to adopt it as quickly as possible as it reduces some of the barriers to enter for us, mainly when we are competing against the bigger player in the market.

We've cooperated in this case with HP. We have other cooperations with some other players in the market and some of them appear also on our website. And we believe that part of NFV is to do the interoperability test and demonstration of the technology with key players in the market in order to help operators understand what they can do with this technology.

We will continue to do that and cooperate with different players in the market, also with HP on different fronts and continue to show them different innovative services that you can run in this environment.

In terms of adoption of NFV, what we think today is mainly TRIS and interoperability test and large TRIS that are being done by many operators. We expect that some of the operators will start rolling out this type of networks probably in the second half of next year. And I know that there are some operators that are -- that might start earlier. But I'm talking about the bigger part of operators with meaningful rollouts. I expect to see that at the second half of 2016.

In terms of sales, we are preparing ourselves to this environment, and as you saw earlier, we focus more and more on the services that we are delivering and many of these services can run in any environment, including NFV environment, not necessarily on our platform.

We also moved the entire software that we have on our platform and enable it to run in an NFV environment. So you can actually deploy a service gateway with all the services in an NFV environment. This will eventually move our sales into more software sales compared to what we have today. We encourage that and we will be happy to get there. I think the transition will be a slow one. It won't happen overnight. We will start to see it at the second half of next year and it will take a few years until this transition will fully happen.

Thank you. And then, Shmuel, this one is for you. I might have missed -- you said the -- what was the expectation on breakeven?

About $26 million taking into account typical gross margin, typical revenue mix, with average commission and other variable expenses.

All right, thank you. Thanks.

Thank you.

Thank you, Catharine.

Thank you. There's no more questions at this time. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

Thank you.